Is the weak US dollar bad for everyone?

Saturday July 4, 2009

The dollar has
been consistently weak throughout 2007 and 2008. The decline came
shortly before the credit crunch started to hit in America and the
dollar has not recovered.

Although it is easy to look back
and to assert that the dollar weakened as a result of the credit
crunch, this is not in fact the case. The dollar was weak prior to
this, indeed the fact that it was weak when the credit crunch hit, did
not actually help to ease the crisis that hit US markets.

Its
decline started as early as 2004. The US was faced with a massive
trade deficit and many financiers and economists felt that the best way
to deal with this, was to allow the dollar to become weaker. The
weaker it became, the more trade would be able to recover on overseas
markets (or so the reasoning went).

In addition, the euro was
strong and the fact that it was kept strong by the European Central
bank, did little to help the dollar. But the situation seemed to be in
control and the weak dollar was not a major cause for concern.

Some
people (particularly those outside the US) felt and continue to feel
that the US dollar being weak is not necessarily a bad thing since the
US dollar has long held a status of dominance in the world’s financial
markets. As a result it has been exceptionally strong and indeed is
the world’s most popular reserve currency. After all, countries that
are not so rich as America try to get their hands on the dollar because
it is a surety and if you have dollars, well things can’t go that wrong
can they?

The dollar is also the unit of measuring the price of some items, particularly gasoline, in the form of petrol as well as gold.

So
in terms of influence the dollar is influential and indeed, it has been
influential for some time. This has led to the dollar and its fortunes
being keenly watched by people all over the globe and since it suffered
a period of decline, many people are now wondering whether the dollar
will ever recover fully and whether it will reach the giddy heights
that it did in the 20th Century.

The US dollar and the Euro

The
European Union and its Central Bank are keen to see a stable and
powerful euro and indeed this has been achieved. The euro is now
exceptionally strong and it is used as the standard of currency in 15
countries.

This makes the economic strength of the euro very
great indeed. It will also become more powerful as time goes on.
Countries that have joined the European Union since 2004 will have to
adopt the euro as their legal currency and it will then become even
more widely used throughout the continent of Europe.

Any
country wishing to join the euro has to show that it has, to a large
extent, achieved economic stability and that their economy isn’t
suddenly going to go into meltdown.

This is a very clever
move on behalf of the EU. It has, through introducing this criteria,
ensured that the basis for the economy of the European Union as a whole
is stable and that it will not be weakened by new countries joining.
In short, it is operating a policy of self-protection, ensuring that it
is strong enough to weather economic declines and any booms or busts
that may take place. It has strapped on its safety belt and knows that
there may be bumpy times ahead, but it is keen to take the ride anyway.

It
has consistently kept the euro strong, so that the euro is now the
world’s second most popular reserve currency and countries from all
over the world are now becoming desperate to get their hands on the
euro, regarding it as a stable unit of currency that will be resilient
and will make it through when indeed the dollar may not.

If
we contrast this economic thinking with the US, it soon becomes
apparent just who is really in control. The US has, over the last few
years, seen a huge rise in government spending. Yet this spending has
been funded from nothing, in other words, the government have actually
overspent. Some people have been predicting since 2006, that a
devaluation of the dollar is actually inevitable, due to the fact that
the trade deficit situation is so bad and the government have just kept
on spending.

In addition, consumer spending and the credit
crunch have been two major factors that have contributed to problems in
the US economy, yet lessons do not seem to have been learnt.

Credit and consumer spending

Thirty
years ago people had a very different approach to money. People
worked, they earned money and then they spent that money and saved a
little to put by for when they had no money, or just needed something
out of the ordinary.

In other words people spent only money
that they had. There was little concept of credit, only cash that had
been earned or saved. Occasionally people may have bought something
using a hire agreement, but this was not considered to be always a good
thing. The whole ethos of the era was to buy what you could afford,
spend wisely and then save for a rainy day.

My, how times
have changed. The whole way of thinking about spending and saving has
changed dramatically and nowhere more so than in the US. Credit has
become the way of life for a great many people. You don’t have the
money? Well that’s ok, because you can just put it on your credit card
and then pay it off when you can.

Some economists love the
concept of credit, because it allows the injection of ‘liquid’ money
into the economy. If we earn our pay checks, spend wisely on what we
need and then put a little away for a rainy day, then the whole economy
can be a little slow and money just doesn’t flow. Indeed consumers may
also get nervous about spending money.

If, however, we can
have credit cards, then we can just go out and buy what we want without
thinking about it. The money in circulation then becomes liquid, as it
flows onto the markets. Indeed at times in the US, it doesn’t actually
flow, it is more like a cascade from Niagara Falls.

This kind
of spending is great when everything is looking perky on the economic
front, but in the US, the credit crunch hit with a bang from 2006
onwards.

People who had acquired not just one mortgage, but
two and a number of credit cards, found that they could not make the
payments on their mortgages or on their credit cards. Debts started to
accumulate and things got very tight for people, particularly those who
lost their homes and who faced crippling mountains of debt.

Consumer
spending thus contributed to the credit crunch (albeit in a small way)
but it is more the philosophy behind it that is interesting. The
extensive use of credit cards and consumer spending that just increases
and increases, with little perception of the consequences, has also
made the US economy vulnerable. People spent and spent, they consumed
and consumed. They didn’t think about how they were going to pay all
that money back. Then oil prices started to go up and the dollar
weakened. Gas cost more and so living expenses were higher and
suddenly it was impossible, or at least very difficult to get more
credit.

So the US was being shown, effectively, that
everything comes at a price and that consumers had consumed, but now
they had to pay for their consumption.

The government
however, had done little to challenge the consumer habits of its
people. It had adopted an approach of just letting things be, in the
great American tradition. Yet by simply allowing consumer spending and
consumption to carry on, rampant and unchecked, the government
ultimately did its citizens no favour. It simply let them become
vulnerable.

The European Central Bank does seem more
concerned with controlling certain aspects of the European economy,
thus offering its residents at least a little more protection in terms
of the credit crunch.

So the US seems to almost have been
sleepwalking into the mess it now finds itself in, whereas the EU,
through its Central Bank, has taken a much more protectionist
attitude. But compared to the US, it is certainly looking healthier!

OPEC and the euro

OPEC,
the oil producing export countries are a very powerful body of
countries. Basically, they control the oil that flows throughout the
world. The middle-eastern countries are actually the most powerful,
since they control the oil that is exported from the middle east and
although oil may be produced in other parts of the world, the middle
east is really the area that counts.

OPEC, since 2006 have
been switching their money from holdings that are in dollars to the
euro. This means that the OPEC countries prefer to hold euros because
they perceive it to be a stronger and more resilient currency. If they
have dollars, whilst other currencies become stronger, then they lose
money. If, however, they can have euros, then as the dollar declines,
they will make more money, since the euro will get stronger. This
‘switching’ started in 2006, when in one year they switched over $5
billion from dollars to euros.

Effectively this sent out a
signal that OPEC was switching sides, instead of backing the dollar, it
was going to back the euro and to some extent the yen. These looked
safe, whilst the dollar sadly, did not.

This was a clear
indication that the dollar no longer had, to a large extent, a monopoly
on being the preferred currency of the world. In short, the dollar was
starting to lose its grip.

This decline was then further
exacerbated by the fact that the dollar could buy less oil. As the
dollar became weaker, it had to pay out more for imports. Since oil is
imported, this meant that less oil could be bought for $100. The costs
of increased oil had to be passed on to the consumers in the form of
increased gas prices and so the US becomes even worse off and its cycle
of decline becomes stronger.

The US and the weak dollar

Some
economists argue that for the US, the weak dollar is not the end of the
world. When the dollar is weak, then American capital markets look a
more attractive option for foreign investment companies. In addition,
the weak dollar makes the US a preferred destination for overseas
visitors. Since they can get quite a lot of dollars for their money,
then can then inject capital into the economy and this time, it is cash
from outside that is being injected, not just credit circulated
internally within the US.

In addition, the trade deficit can
be eased somewhat. US companies will find that their goods become more
readily affordable to overseas firms, so there is actually increased
trade and the deficit can be eased.

Yet, these arguments
almost fail to take account the context in which the dollar is weak.
Ordinarily, yes, the weak dollar could cause the effects such as more
visitors and better trade.

But the US tourist industry has
not fully recovered since 9/11. Some people are still concerned about
the risk of a terrorist attack, so they do not visit. Whilst many more
visitors are coming than in the immediate aftermath of 9/11, it would
have been reasonable to think that the weakness of the dollar would
have had people pouring into the country, but this has not happened.

Moreover,
the credit crisis also affects trade. Many businesses were hit by the
credit crunch, as individuals and as businesses. Small businesses in
particular were hit. So this meant that some businesses had gone bust,
so they simply weren’t in a position to trade with foreign companies,
so the weak dollar was little comfort to them.

In addition,
the culmination of the credit problems, the weakness of the dollar and
the general, even sharp decline of the US economy, undoubtedly led to a
lack of confidence. The US started to become fearful and nervous about
how bad things were going to get and this depression started to seep
into the national psyche.

So for the US, there is little in
the way of joy that the dollar is weak and it is likely that the dollar
will simply decline and may even have to undergo the humiliation of
being devalued. Only time will tell. But how does the rest of the
world view the weak dollar?

Global responses to the weak dollar

The
main rival to the dollar, namely the euro, is controlled by the
European Central Bank, which is obviously not losing too much sleep
over the fact that the dollar is weak. As the dollar declines, the
euro starts to creep up and become more and more powerful. It is much
more stable than the dollar and thus it can look forward to perhaps
even knocking the US off its position as the No 1 currency in the world.

Due
to the fact that oil is priced in US dollars, the costs for oil
throughout Europe, particularly those countries that have the euro as
their currency, has managed to be kept significantly lower than in the
US. So, again, Europe wins.

There are also some hidden
casualties from the weak dollar though. The aid that the US gives to
developing countries has now much less worth than it had before, so
they are less able to develop. However, this to some extent can be
counterbalanced by the fact that any aid they get from Europe and the
UK in particular will be worth more. It depends on the ratio of US and
European funding: some countries will be winners, others will lose out.

Lessons to be learned

In
a few years time, or even a couple of decades down the line, economists
and historians may point to the weakness of the US dollar as being the
time that the current started to flow against the US. Instead of being
the absolute world dominant currency, the US now started to be viewed
as a leading currency, but not as the leader.

However, until
the dollar regains some of its strength, there appears to be some
unease globally about how the world can recover from all the crises
that has hit its various economies over the last few years.

Perhaps
some good will also come from the weak dollar in the sense that the US
can no longer assume that it is the dominant economic leader and it has
to earn that position, not simply assume it as a given. More
importantly, perhaps the rest of the world can also learn that if we
simply consume, without the means to repay, there will be a cost,
somewhere along the line.